Consumer spending. Is it just a rainbow?

Some indicators suggest capacity for growth | Michael Porter

This year started with promise – we anticipated that our economy would grow at 1.7% this year. That is nothing to write home about, but it would have been an improvement on the past two years, and a chance to let momentum develop. Then politics intervened. What has transpired since has been well documented, and our economy remains in critical condition.

That said, there appear to be pockets of hope that the worst may be behind us. Critical to a turn in our economy is a turn in consumer spending – and some of the recent results from retailers suggest that consumers have a little more cash in their pockets. Is this really the case?

Before we start, I think it may be useful to look back over the past ten years. It has been a rough decade for the global economy, which has struggled to regain its footing post the financial crisis. But time heals, and momentum is building in most major economic regions. However, the chart below shows how South Africa is being left behind. Whereas historically, our economy has tended to track the trend in the world at large, this relationship has recently broken down. The gap represents the lost opportunity resulting from politics and weak confidence.

The next chart is equally distressing. It shows the trend in GDP per capita. A rising trend means that the average South African is getting wealthier, and vice versa. In 1994, the ANC inherited a weak and highly-skewed economy. Through reforms (trade liberalisation), improving terms of trade, and public-sector employment that created a growing middle class, GDP per capita rose steadily. On average, South Africans became wealthier, and that manifested itself in an economic boom from 2003 to 2007. However, recently, that momentum has been lost, and GDP per capita has actually contracted over the past two years. This is a direct function of our weak economic growth.

Trying to understand the outlook for consumer spending is tricky, as there are dozens of variables than can influence the way people feel and act. So a good place to start is consumer confidence. After all, confidence (or the lack thereof) is what drives consumers to make decisions. Unfortunately, this metric does not fill us with hope. In absolute terms, confidence – both business (which influences investment decisions) and consumer – is weak. We know the reason for that. Unfortunately, there is nothing to suggest an immediate change in trend either – and this is likely to be the case until the end of the year.

Other factors that concern us about the ability of consumers to increase spending include:

1. Unemployment remains stubbornly high, and rising. The pressure is coming from all sides of the economy. The mining sector continues to shed jobs – recently Impala Platinum announced that it was entering discussions with unions for the loss of 3 500 jobs. But job losses have spread to the services sector as well. The banks are all downsizing as they try to take advantage of efficiencies created by electronic channels. Government – the former anchor for employment – has also frozen new jobs as they try to bring their deficit under control. In short, in the absence of a change in political direction, we find it hard to forecast an improvement in unemployment.

2. Fuel prices have been static for a few years, thanks firstly to a falling oil price, and then secondly, to a much stronger rand. Increases in fuel taxes have been absorbed without affecting the pump price significantly. But we are concerned that the trend is turning. Government announced that it may introduce VAT on fuel prices next year (offset by falling fuel levies), but we are sceptical that the overall level of tax will remain unchanged.

3. The rand has weakened slightly in the past few weeks, in reaction to unfolding global events. Specifically, the Bank of England has hinted that UK interest rates may soon have to rise. In the US, the Federal Reserve may announce measures to reduce their balance sheet. Both of these events are negative for emerging market currencies as a group. Even a marginally weaker rand will prevent inflation, and interest rates, from falling much further.

4. Finally, tax collection remains a concern. In the Budget announced in February, Treasury raised taxes by R28 billion, and they forecast further increases of R15 billion in 2018. Given weak collections, it is more likely that taxes will rise by a further R24 billion, and this could be higher if current collections don’t improve.

Yet despite the headwinds articulated above, there are a few reasons to be more optimistic.

1. Inflation has fallen consistently over the course of this year, largely thanks to falling food prices as farmers recover from the drought. At the same time, wage settlements have been set at higher levels – often between 7% and 8%. Given that inflation is now recorded at less than 5%, there is a widening gap and consumers are experiencing an increase in their real incomes.

2. The Reserve Bank cut interest rates in July, but disappointingly, failed to reduce them again at the last monetary meeting. While a reduction of 0.25% is not large by historical standards, it does have an immediate impact on the health of consumers. Recent data shows that the overall level of debt continues to fall – the ratio of debt to income is now just 71.8%. Lower levels of debt together with lower interest rates will bring down the cost of servicing that debt. That provides scope for consumers to either repay more debt, or increase their spending. We do expect interest rates to fall further, but the quantum will be limited, given the risks to inflation.

Retail shares have been under pressure for some time, hence the market is getting excited about a potential change in trend, and share prices have generally recovered well off their lowest levels. The chart below shows the valuations of the two retail sectors on the JSE – food retail and general retailers. While valuations have improved, especially for general retailers – companies are not as expensive as they were a few years ago – they are hardly cheap given the anemic outlook. Valuations were much cheaper back in the mid-2000s, during a period when consumer spending was booming.

A real increase in income, coupled with falling interest rates, provides an immediate boost to consumers’ disposable income. In our opinion, this impact is being felt in the economy, as retailers report slightly improving sales figures. This may last into 2018 as the benefit of lower interest rates endures. But given that the headwinds are more long-term in nature, this cycle is likely to be very shallow and short, unless there is a rebound in confidence. That, like so many other variables, all hinges on events in December.

Michael Porter is the chief investment officer of the Harvard House Group

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